Court denies consolidated NOL deductions because predecessor losses remain subject to SRLY limits
HBM Holdings Co. v. Commissioner United States Tax Court. No. 19735-23No. 3881-24.
A consolidated group cannot use a predecessor corporation’s pre-group NOLs to offset other members’ income if those losses are still limited by the separate return limitation year rules and the successor parent does not have its own taxable income.
Holding
The Tax Court determined that HBM Holdings Co. could not use about $108 million in net operating loss carryovers from Delavau Holdings, LLC for consolidated NOL deductions in 2018, 2020, and 2021. Delavau was considered HBM’s predecessor under the consolidated return rules, and its preliquidation tax years were still separate return limitation years. HBM’s founding group members also did not qualify as an SRLY subgroup. The Court granted partial summary judgment to the IRS.
Why It Matters
This decision highlights an important limit on §381 attribute succession. An acquiring corporation can take on a liquidated corporation’s NOLs, but those losses do not automatically become unrestricted for the acquirer.
The common parent exception to the SRLY rules does not cover losses created by a predecessor of the common parent. This difference was key to the outcome.
The SRLY subgroup rules require that members were previously part of the same affiliated group. Simply having common ownership or economic ties before consolidation is not sufficient.
This decision is especially important for restructurings that involve S corporations, QSubs, entity classification elections, §332 liquidations, and forming a consolidated group later on. The order of these transactions can affect whether inherited NOLs can be used to offset group income.
Key Facts
HBM Holdings Co. was the common parent of a consolidated corporate group.
Mississippi Lime Co. acquired Delavau Holdings, LLC in 2012. Delavau had approximately $78 million of NOL carryovers at that time and was treated as a loss corporation under §382.
HBM was formed in 2014 through an F reorganization and elected S corporation status. Several subsidiaries, including Mississippi Lime, later operated as qualified subchapter S subsidiaries, or QSubs.
HBM revoked its S corporation election effective July 1, 2018. The QSub status of four subsidiaries ended on the same date.
Delavau elected to be disregarded as a separate entity from HBM, effective July 1, 2018. That election caused Delavau to be deemed liquidated into HBM as of June 30, 2018.
The parties agreed that §§332 and 381 applied to the deemed liquidation. HBM therefore succeeded to Delavau’s NOL carryovers, which had grown to approximately $108 million.
HBM then became the common parent of a consolidated group beginning July 1, 2018. Delavau was never a member of that consolidated group.
HBM had no taxable income on a separate-entity basis for the short 2018 tax year through 2021.
The consolidated group nevertheless used Delavau’s NOL carryovers to claim CNOL deductions of approximately:
$13.55 million for the short 2018 tax year.
$14.97 million for 2020.
Approximately $1.1 million for 2021.
The IRS disallowed the deductions under the SRLY rules.
Statutory or Regulatory Framework
Section 381 generally allows an acquiring corporation in certain tax-free corporate transactions, including qualifying §332 liquidations, to succeed to specified tax attributes of the distributor or transferor, including NOL carryovers.
The coThe consolidated return rules add another limit through the separate return limitation year (SRLY) rules. An SRLY usually includes a separate return year of a group member or its predecessor. Treas. Reg. §1.1502-21(c), an NOL generated during an SRLY generally may offset consolidated taxable income only to the extent that the consolidated group’s income is attributable to the member that generated or succeeded to the loss.
Treas. Reg. §1.1502-1(f)(2)(i), known as the lonely parent rule, excludes some separate return years of the current common parent from being considered SRLYs.
The subgroup rules offer another exception. Members can usually combine their income for SRLY purposes if they joined the current group together after being in the same affiliated group before.
Arguments
Taxpayer argued:
Section 381 caused HBM to inherit Delavau’s NOL carryovers as HBM’s own tax attributes.
Because HBM was the common parent of the consolidated group, the lonely parent rule should prevent Delavau’s historical separate return years from being treated as SRLYs.
Delavau should not qualify as HBM’s predecessor because HBM was not yet a member of the consolidated group when the §381 transaction occurred.
Alternatively, HBM and the other founding members should qualify as an SRLY subgroup because they were jointly controlled prior to the formation of the consolidated group.
Government argued:
Delavau remained the source of the NOLs even after HBM succeeded to them under §381.
Delavau was HBM’s predecessor under Treas. Reg. §1.1502-1(f)(4).
The lonely parent exception applies to the common parent’s own separate return years, not the separate return years of its predecessor.
The founding members could not form an SRLY subgroup because they had never previously belonged to another affiliated group together.
Since HBM did not have its own taxable income during the relevant years, the SRLY limitation stopped the inherited Delavau losses from being used to offset the income of other group members.
Court’s Reasoning
Section 381 allows tax attributes to be transferred, but their origin still matters. The regulations still treat NOL carryovers inherited from another company differently from those created by the acquiring company.
Delavau met the regulatory definition of a predecessor because it distributed assets to HBM in a transaction to which §381 applied. The regulations did not require that HBM be a consolidated group member when the liquidation occurred.
The Court rejected HBM’s proposed timing limitation because Treas. Reg. §1.1502-1(f)(4) contains no such requirement.
Delavau’s preliquidation years remained separate return years of HBM’s predecessor. Those years therefore fell within the general definition of SRLYs.
The lonely parent rule did not apply. Its text refers to separate return years of the common parent itself and does not include separate return years of a predecessor.
The founding members did not qualify as an SRLY subgroup. Before July 2018, HBM was an S corporation and the other entities were QSubs disregarded as separate from HBM. They therefore had not previously belonged to another affiliated group.
Because HBM generated no separate taxable income during the years at issue, there was no HBM-attributable income against which the Delavau SRLY NOLs could be used. Income earned by the other founding members could not expand the limitation.
Result
The Tax Court approved the IRS’s request for partial summary judgment, denied HBM’s cross-motion, and did not allow the consolidated NOL deductions related to Delavau’s NOL carryovers for 2018, 2020, and 2021.
The Takeaway
Section 381 succession does not make inherited NOLs the same as a successor corporation’s own losses for consolidated return purposes. Groups that acquire or inherit losses before consolidation must check the SRLY rules separately before assuming those losses can offset other members’ income.
List of Citations
I.R.C. §332: Governs qualifying liquidations of subsidiaries into parent corporations.
I.R.C. §381: Governs succession to specified tax attributes, including NOL carryovers, in qualifying corporate transactions.
I.R.C. §382: Limits the use of NOLs following certain ownership changes.
I.R.C. §1361: Governs S corporations and qualified subchapter S subsidiaries.
I.R.C. §1504: Defines affiliated groups for consolidated return purposes.
Treas. Reg. §1.1502-1(e): Defines a separate return year.
Treas. Reg. §1.1502-1(f): Defines SRLYs, predecessors, successors, and relevant exceptions.
Treas. Reg. §1.1502-21: Governs consolidated NOL deductions and the SRLY limitation.
Treas. Reg. §1.381(c)(1)-1: Governs treatment of NOL carryovers succeeded to under §381.
Treas. Reg. §301.7701-3: Governs entity classification elections and deemed transactions resulting from changes in classification.
Wolter Construction Co. v. Commissioner, 68 T.C. 39 (1977), aff’d, 634 F.2d 1029 (6th Cir. 1980): Supports applying SRLY restrictions to predecessor losses inherited by a successor common parent.
Dover Corp. & Subsidiaries v. Commissioner, 122 T.C. 324 (2004): Addressed succession to business history under §381 but did not establish that inherited NOLs become indistinguishable from the acquirer’s own attributes.
AptarGroup Inc. v. Commissioner, 158 T.C. 110 (2022): Supports interpreting consolidated return regulations according to their text and structure.
Florida Peach Corp. v. Commissioner, 90 T.C. 678 (1988): States the Tax Court’s standard and purpose for summary judgment.